The South African pension system is based on the general three-pillar design, where pillar 1 consists of a non-contributory, means-tested social grant, pillar 2 of occupational funds and pillar 3 of voluntary retirement savings.
The means-tested State Old Age Grant (SOAG) provides a monthly minimum income of R 1,410 (2015) to a person over the age of 60 who meets the means-tested criteria. For persons over the age of 75, this amount increases to R 1,430 per month. If an individual is admitted to an institution that has a contract with the state to care him/her, the social grant is reduced to 25% of the maximum amount. The SOAG is financed from general revenues and aims to reducing poverty among the elderly.
The SOAG has been reported to be the main source of income for about 75% of the population in retirement, which implies that about three quarters of the population have no formal pension provision.
Employer-based retirement plans have a long history in South Africa. The retirement funding system has been in place since the promulgation of the Pension Funds Act in 1956. These occupational retirement plans are however limited to those employed in the formal sector. In this sector however, the coverage rate is quite high by international standards.
Pension schemes can be pure defined benefit (DB) or defined contribution (DC), or some hybrid of the two. DC arrangements appear in the form of either a pension fund or a provident fund. The difference between the two is drawn with regards to tax-exempt contribution limits and retirement benefit options. Provident funds may provide retirement benefits in one lump sum payment while pension funds are only allowed to provide one third of the total value as a lump sum.
Today, the majority of employees in the private sector are covered by DC schemes, whilst DB arrangements are more common in the public sector. The industry saw a large shift from DB to DC during the 1980s and 1990s. The shift was generally viewed as advantageous for members due to the poor withdrawal benefits received from DB funds and favourable investment returns enjoyed by DC members during this time.
Underwritten funds, i.e. policies issued by registered insurers, have been the predominant form of pension provision. Self-administered funds, where the trustees perform either all the functions themselves or outsource one or more of these functions, have however experienced strong growth. The South African environment has also seen considerable growth of multi-employer or “umbrella” funds, which are DC in nature.
Underwritten and self-administered retirement funds are regulated by the Financial Services Board (FSB) and governed by the Pension Funds Act. In contrast, official funds (i.e. funds established by special laws for State employees, certain parastatal institutions and special sector funds) are supervised by other governmental agencies and governed by acts other than the Pension Funds Act.
Additional tax-incentivised saving for retirement occurs through voluntary savings vehicles, mainly in the form of Retirement Annuity (RA) fund policies, primarily offered by the insurance sector. In the case of RAs, benefits become available from age 55 onwards. They are subject to the same regulations as pension funds in that a maximum of one third may be taken as a cash lump sum and the rest used to purchase an annuity.
Boards of retirement funds should establish an investment strategy which should be monitored and reviewed regularly. Overall, prudential limits apply, with the following maxima in broad terms:
There are also overall limits, e.g.:
Employer contributions to approved pension and provident funds are tax-deductible up to 10% of the employee’s remuneration. In practice, the Commissioner of the Inland Revenue allows up to 20%, with even higher limits allowed if justifiable. Employee contributions to pension funds are tax-exempt up to the greater of 7.5% of remuneration and R 1,750 (2015). Employee contributions to provident funds are not tax deductible and are therefore normally non-contributory.
Lump sum amounts are tax-free up to a certain level after which a progressive tax system is used. Benefits from a retirement fund to which contributions did not qualify for tax-exemption may be paid out tax-free.
The tax system is under review and changes are expected to align the tax treatment of different retirement savings vehicles. This is expected to be implemented from 2016 or 2017.
A large proportion of South Africa’s population lack effective access to an affordable retirement funding plan due to the economic structure of the country. South Africa has a high rate of unemployment and a substantial part of the working-age population is informally employed.
In order to address income poverty among the elderly, the government has proposed a social security and retirement reform. The key objective is to set up an appropriate social security concept that prioritises the needs of people with insufficient incomes or those in the informal sector, leading towards the creation of a comprehensive social security system.
In line with international practice, the government is considering the introduction of a mandatory earnings-related contributory system administered on a payroll-tax basis. The income replacement to be provided under this system is however considered to be insufficient, especially for higher earners. Participation in any form of occupational pension fund or individual retirement fund will therefore likely be mandatory up to certain earnings limits. In addition, voluntary contributions will be encouraged through tax incentives.
The proposed mandatory contributory earnings-related savings and benefits system will be a funded system with contributions accumulating in individual accounts rather than financed on a pay-as-you-go basis.
Further reforms which are expected will introduce the preservation of retirement benefits (currently the full withdrawal benefit from retirement funds may be taken in cash on leaving an employer) and remove preservation funds, i.e. all funds should in future provide an annuity benefit.
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